Volatility term structure

Definition

The volatility term structure is implied volatility as a function of expiration date at a fixed moneyness: how the market prices movement over different horizons. Upward-sloping (longer-dated IV above short-dated, “contango-shaped”) is the calm-market norm; inversion (short-dated IV above long-dated) marks stress or a scheduled near-term event. The platform’s vol_term_state concept classifies the current shape.

How it works / structure

• Measurement: ATM (or fixed-delta) IV per listed expiry; index-level versions use VIX-style calculations at multiple tenors or listed volatility futures (the futures curve is the tradable term structure; Cboe publishes the methodology and data).
• Normal shape and why: longer horizons carry more model and event uncertainty plus a term volatility risk premium — calm markets slope up; panics invert the curve because near-term risk is repriced hardest.
• Event localization: a scheduled event (earnings, FOMC) bumps IV specifically in expiries containing it; the “event variance” can be backed out by comparing adjacent expiries (event-earnings, opt-expected-move).
• Strategy relevance: calendars and diagonals are term-structure trades (strategy-calendar-spread — short the front, long the back, harvesting the differential decay and slope).
• Simulation parameters: per-expiry IVs; term-state (vol_term_state) as an entry filter; slope-shift scenarios in stress runs.

When it applies

Reading market stress (inversion is one of the cleanest regime markers — regime-volatility), pricing event risk into specific expiries, structuring multi-expiry trades, and volatility relative-value theses (front rich vs back given a known calendar).

Risk profile & failure modes

• Inversion persistence: stressed curves can stay inverted far longer than a mean-reversion thesis budgets for.
• Roll-down assumptions: harvesting an upward slope (short front, long back) assumes the curve holds shape; a spot shock inverts it and the “carry” reverses violently — documented in the VIX-futures basis literature.
• Event mis-mapping: mislocating which expiry contains an event (calendar errors, moved report dates) breaks the whole adjacent-expiry comparison.
• Tenor interpolation: constant-maturity IV between listed expiries is an interpolation with method-dependent artifacts.

Evidence & limits

Term-structure shape and its stress behavior are directly measurable (Cboe data). Simon and Campasano (2014) documented that the VIX futures basis (curve slope) predicted futures returns in their sample — the standard citation for slope-harvesting evidence, with its documented drawdown episodes; slope strategies are parameterized strategies to test, not established income.

Falsifiable-thesis examples

Illustrations only, not signals:

• “The index volatility curve, inverted today, will return to upward-sloping (1M below 3M) within 20 trading days” — falsified by the daily term-state series.
• “X’s post-earnings front-month IV will fall below its back-month IV within two sessions of the report” — falsified by the two IV prints.

Cross-references

• The level and the other axis: opt-implied-volatility, opt-volatility-skew
• Regime reading: regime-volatility
• Structures: strategy-calendar-spread, strategy-diagonal-spread
• Event mechanics: event-earnings, event-fomc